If you haven’t been following the debate surrounding capping and trading emissions, you’re missing out. Not only does it have implications for how our nation, and the world, produces energy, it has the potential to offer a myriad of opportunities for well-informed investors.
You see, California has been asking for permission to regulate greenhouse gas emissions since 2004, but the philistines at the Environmental Protection Agency (EPA) have yet to grant it permission to do so.
For quite some time the EPA’s excuse was that they didn’t have the power to regulate emissions. That’s funny--greenhouse gases harm the environment and the EPA is supposed to protect theenvironment. Maybe they should consider a name change.
Now, back in April the Supreme Court ruled that the EPA did in fact have the authority to regulate greenhouse gas emissions. Like we didn’t see that one coming.
After that decision, you’d expect everything to be rosy. But this administration doesn’t make anything easy, even obeying Supreme Court decisions. So here we are, a substantial time since that decision, and the EPA still hasn’t given California--and the eleven other states that would do so--permission to regulate emissions.
And while it would be nice to have the federal government’s support, it looks like the rest of America is ready to move on without it.
Already, corporate behemoths like General Electric, DuPont, Johnson & Johnson and others have come together to form the United States Climate Action Partnership.
Even oil juggernauts like Shell, BP and ConocoPhillips have joined this coalition, which calls itself “an expanding alliance of major businesses and leading climate and environmental groups that have come together to call on the federal government to enact legislation requiring significant reductions of greenhouse gas emissions.”
Now you can be certain the environmental groups that are a part of this alliance are there with pure intentions, but I’m willing to bet some of those companies are looking for a way to make a buck from the capping of emissions.
Carbon Market Potential
According to a recent New York Times article, carbon trading is one of the “fastest-growing specialties in financial services.” And companies are scrambling to get “a slice of a market now worth about $30 billion and that could grow to $1 trillion within a decade.”
The article, entitled, “In London’s Financial World, Carbon Trading Is the New Big Thing,” continues: “Carbon will be the world’s biggest commodity market, and it could become the world’s biggest market over all.”
If you doubt that assertion, consider this: Every year humans generate about 38 billion tons of carbon dioxide.
At its current price of about $3.50 per ton--in the U.S.--the potential carbon market stands at roughly $133 billion (38 billion x $3.50). In Europe and in other nations with mandatory caps, carbon comes with an even higher price.
CARBON PRICE CHART
As more and more governments start to regulate their country’s emissions, and as more companies--just as we’re seeing in the US--start to voluntarily limit their emissions, the demand for available carbon credits will skyrocket. And so will their price!
One need only revert to the simple law of supply and demand to see that this industry is going to be huge. If increased demand dictates an increase in price, getting in now could be one of the wisest investment moves you make in the first half of this century.
Carbon’s Current Condition
Carbon dioxide is no longer free, as it once was. It now comes with a price.
It used to be that no one worried about CO2--it was just a gas that had no real use. But as more light was shone on this once useless gas, new theories and opportunities began to emerge. In a matter of just a few years.
Once it was realized that CO2 is a heat-trapping or greenhouse gas (GHG), the entire game changed. There were calls for emissions reductions and in late 1997 a treaty was created by the United Nations (UN) assigning mandatory emission limitations to all signatory nations.
As of today, a total of 169 countries, with the notable absence of the U.S. and Australia, have ratified the agreement. In that time, CO2 has evolved into a precious commodity, expanding its value not only as a GHG, but also in other applications such as advanced recovery techniques for aging oil wells.
Under the Kyoto agreement (and even alongside it) a number of carbon reduction and trading schemes have been established. But there is still some haze surrounding exactly how many markets exist, which are legally binding, and what is to be expected in the future. Hopefully, this will help clear things up.
Clearing the Fog
To date, there are three legally binding carbon trading arrangements and one major voluntary market with legal implications.
Under the Kyoto Protocol, there are two main trading devices. The first, the Clean Development Mechanism (CDM), allows Kyoto countries to offset their emissions by investing in clean technologies in developing countries or purchasing the resultant Certificates of Emission Reduction (CERs) from such projects. The second, called Joint Implementation (JI), allows industrialized countries to do essentially the same thing, only in other industrialized countries.
The other government-backed trading program was adopted by the European Council in 2003 and is called the European Emission Trading Scheme (EU ETS).
In 2006, 1.1 billion CERs (each worth one metric ton of CO2) were channeled through the EU ETS at a value of $24.3 billion.
The last carbon trading pact is the voluntary scheme implemented here in the U.S. through the Chicago Climate Exchange (CCX). This market is still relatively small, but will triple its 2006 value by the end of this year. It is also not federally regulated, so there is more inherent risk.
But as long as companies are trying to reduce their emission--voluntarily or not--there will be significant profit potential for companies that aid in reducing those emissions. And with companies now being called upon to disclose their carbon footprint and climate risk, it looks like carbon reduction industry can only forge vibrantly ahead.
Now, with that out of the way, let’s talk about the possibilities for profit that can be found in the emerging global carbon market.
Institutions
First and foremost, this is a big boy’s game. The sudden surge of capital in the carbon market can be attributed to a flood of investment from large institutional firms.
They invest billions and billions of dollars in what has now become known as Project Finance, or projects that are used to generate CERs. These projects can vary widely in type, from wind farms in the developing world to energy efficiency programs in downtown London. But in the end, either the U.N. or the verification arm of the EU ETS must certify all projects.
Then, once the CERs are reaped from a project, they are sold to companies or countries that need to meet their legally binding targets.
Operations like this have become commonplace for big banks, hedge funds and brokerage firms all over the world. In fact, many of those institutions now have dedicated carbon departments and have assigned positions like Vice President of Carbon Markets or Senior Investment Officer for Carbon Finance--both of which were titles I saw at the conference.
And power players in the financial realm aren’t just looking to finance carbon reduction projects, they’re also offering consulting and risk mitigation strategies.
Earlier I told you that carbon is no longer free. And what power generation companies are realizing now is that carbon has a price even before they generate emissions. That means corporations that generate emissions in any form now have to account for the price of carbon in their business models.
And big banks are now calculating this new business risk before granting loans or underwriting IPOs.
But even though the generation and trading of carbon credits and the mitigation of carbon-associated risk is primarily dominated by large institutional firms, the profit potential for individual investors is still exponential.
Individual Investors
This is because the large funds that have been set up to finance emissions reductions projects are continually looking for new projects to invest in--now more than ever.
Under the Clean Development Mechanism (CDM), large investment firms first went after the low-hanging fruit. They went into China, India, and other developing countries and cleaned up the dirtiest operations they could find. When the CDM was in its infancy, these projects turned out to yield huge returns.
In fact, just 3% of the registered CDM carbon reduction projects accounted for 55% of total carbon reductions. Currently, there are 222 projects registered under the CDM. These projects are preventing 65 million metric tons of carbon from entering the atmosphere every year. But the current demand for CERs is as high as 500 million metric tons. You can see why more projects are needed.
And although the U.S. hasn’t ratified Kyoto, it is primarily our technology that is driving these projects, especially as the carbon fruit gets harder and harder to pick. The main markets for carbon reduction projects are as follows:
- Energy Efficiency/Demand-side management
- Methane Capture/Waste-to-Energy
- Carbon Capture
- Power Plant Revamping
- Fuel Switching
These are all sectors in which the U.S. excels, and from which it is possible to reap massive profits. And with the recent market sell-off, there are some good bargains out there.
Energy Efficiency--Valuable Negawatts
But the most promising opportunities for emissions-related profit will be in the realms of energy efficiency and demand-side management. That means instead of finding new ways to produce energy, we simply find ways not to use it. This is quickly becoming known as negawatts.
A company that has been white hot in this sector is Echelon Corporation (NASDAQ: ELON). Echelon is an energy management company that provides software and hardware solutions to help companies and homeowners reduce the amount of power they consume.
This company went gangbusters in the past six months as it announced deal after deal - including major agreements with global powerhouse McDonald’s, key Danish utility ELRO, and Russian energy provider Energoauditcontrol.
A similar company is EnerNOC, Inc (NASDAQ: ENOC). EnerNOC collects energy by reducing demand at thousands of end-use customer sites (commercial, institutional, and industrial businesses and organizations) to provide significant and immediate megawatt capacity when high peak demand compromises grid stability.
This alleviates grid constraints effectively, economically, efficiently, and environmentally and defers or eliminates the need to build costly peaking power plants.
In fact, EnerNOC creates the equivalent of a new peaking power plant every three months--with absolutely no net increase in carbon emissions. This company is still hovering around its IPO price of six months ago. But I suspect EnerNOC will emerge as a prime player in the negawatt industry.
Waste-to-Energy-to-Profits
Waste-to-energy (WtE) in its strictest sense refers to any waste treatment that creates energy in the form of electricity or heat from a waste source that otherwise would have been disposed. Some WtE processes result in usable fuel commodity, such as methane, methanol or ethanol, upon completion of process.
Some modern WtE technologies are considered to be a source of partly renewable energy by the USA federal government and in the 24 US states (plus D.C.) that have established Renewable Portfolio Standards (RPS). Types of WtE projects include:
- Gasification
- Anaerobic Digestion (methane)
- Incineration
- Landfill Gas Recovery
Covanta Holding Corp. (NYSE: CVA) may turn out to be a good play in this arena. Involved in waste-to-energy, renewable projects, and landfill gas projects, this company could soon become a CER Mecca.
Another no-brainer play in waste-to-energy conversion is Waste Management (NYSE: WMI). The company offers collection, transfer, recycling, disposal, and waste-to-energy, and methane gas recovery services in the US, Puerto Rico, and Canada.
Waste Management is an industry stalwart, and even bears the sector’s namesake. And with earnings per share of $2.10 and a P/E ratio of under 18, this is seemingly a screaming buy.
A little-known company operating in this sector is Thermoenergy Corp. (TMEN.OB). Trading around $1.00, this is a highly speculative play. But it has operations in three sectors, including carbon capture, heat-to-energy, and waste-to-energy, and could prove to highly pay off investors with an appetite for risk.
Indirect Plays, Utilities, and Foreign Exchanges
As with all promising markets, the big boys are trying to get in early. Surely you’ve seen the ad campaign running for GE titled, Ecomagination. And now, BP and Chevron are even trying to break in to this sector.
These companies are surely profitable, even though their intentions are questionable. If you’re looking for a safer way to play the growing carbon market, a well-established utility may be the way to go.
One such utility is American Electric Power (NYSE: AEP). They’ve been buying up wind generation facilities hand over fist, and have also come up with a plan to help reduce global emissions through 2020.
There’s also the AES Corporation (NYSE: AES), which operates as an electric utility here in the U.S. In January, AES inked a deal with GE to create an annual production volume 10 million tones of GHG offsets by 2010. To do this, AES is pursuing a variety of projects, including the reduction of methane from agricultural waste, landfills, coal mines and wastewater treatment and through energy efficiency projects and electricity generation from renewable sources.
Many of the project AES will facilitate for GE will use technology stemming from another joint venture with AGCERT (LSE: AGC.L). Per that agreement, AES will acquire 9% of AGCERT and their AgriVerde technology, which captures methane from agricultural and animal waste products. Also under that agreement, AES will create 20 million tones of greenhouse gas emission reductions by 2012.
And it only makes sense that some European-based companies are far ahead of their American counterparts. Most of those countries have a carbon reductions scheme in place for quite some time now.
EcoSecurities (ECO.L), for example, makes money by sourcing, developing and trading emission reductions all over the world.
Trading Emissions PLC (TRE,L) also trades in London.
They make capital profits from purchasing emissions assets at appropriate prices. Trading Emissions also generates income from the provision of finance for selected programs such as aggregation, monetization, collateralization, and other innovative approaches to carbon trading markets.
And then, of course, there’s Climate Exchange PLC which owns an exchange for trading carbon emissions in Europe as well as the Chicago Climate Exchange (CCX) here in the U.S.
If there’s a stock that truly shows the explosiveness of the carbon industry, it’s this one. It’s shown gains of well over 310% in the last year alone. (Don’t let the prices of these London-traded stocks fool you. Their prices are shown in Pence.
And there are plenty more opportunities. Soon, carbon will become a full blown commodity. Its emissions will be regulated all over the world and companies will have to divulge their carbon footprints as public information. A thriving carbon market will be commonplace.
Aside from the stocks highlighted here, companies that reduce carbon emissions by way of their everyday operations will also benefit from the carbon revolution. Of course, the majority of companies that do this are renewable and clean energy companies.
When that happens, companies that Green Chip has been following for years will begin to take additional profits from the sale of carbon credits. It will be a great time to be in this sector. And to be a Green Chip Stocks member.